The NFT market will 100x from here, as decentralised finance (DeFI) unlocks the next wave of innovation.

Better data aggregation and visualisation will be key to this evolution.

NFT liquidity is being opened up by platforms such as NFTfi, which enables NFT owners to borrow money, by using their NFTs as collateral. However, high volatility and idiosyncratic risks across NFT projects mean pooled collateral will be needed.

The path to mass adoption will require more advanced infrastructure, better data and pooled collateral.

Overview

Non-fungible tokens (NFTs) exploded in 2021 and it feels like everyone is talking about them. It was the year that NFTs went mainstream, with the help of NBA TopShots, Beeple’s record breaking sale at Christies, as well as celebs and powerful communities developing around high-profile NFT projects, such as Crypto Punks and Bored Ape Yacht Club.

Despite the hype, most projects are only scratching the surface when it comes to the potential use cases for NFTs. During 2022 we will see NFTs morphing in weird and wonderful ways - think political tokens, NFT leasing and derivatives. @lililashka provided a good overview of some of these initial use cases, but this is still only just the beginning.

As more people jump into the Web3 ecosystem, allocate more capital to NFTs and, in some cases, see the value of their NFT portfolios rise dramatically, the need to access liquidy grows. One exciting use case involves asset-backed lending. Yep, that’s right - borrowing money and using an NFT as collateral. There is huge potential here and it solves a rapidly growing problem.

Let’s jump in…

DeFi lending against NFTs explained

Collateralised lending and pawnbroking isn’t a new business, but using digital assets such as NFTs as collateral is a fairly novel concept.

Let’s say you are lucky enough to own a Bluechip NFTs such as a CyptoPunk, but need some extra cash. You can now use that CryptoPunk as collateral for a loan. Platforms such as NFTfi allows borrowers to use any ERC-721 token as collateral. Lenders can then offer you a loan. Once the borrower accepts the loan proposal, the NFT will be locked into a smart contract, similar to an escrow account.

The beauty of lending in DeFi, is that the smart contract takes care of settlement, repayment and default scenarios. For example, let’s assume the borrower stops making repayments. The smart contract will simply transfer the NFT to the lender, eliminating the need for any sort of debt collection process.

What’s the point?

NFT lending platforms are addressing a growing problem for NFT collectors and investors: the need for liquidity.

For the borrower, the primary rationale would be to unlock capital tied up in NFT assets or to leverage up an NFT portfolio. For the lenders, it’s primarily going to be for interest payments. Although, in some cases, lenders are hoping that overstretched borrowers default on their secured loans, so a lender can take possession of a particular NFT.

Current problems faced by lenders

Price discovery

How much is the NFT you are lending against actually worth? Floor prices provide an OK starting point, but most of them don’t represent a real bid. There are also numerous idiosyncratic risks related to each NFT project that also make valuation challenging. This means that, as a lender, significant time and energy is often required on a case-by-case basis to evaluate each NFT and, even then, it’s mainly a guess.

Volatility

We have established that price discovery is challenging and imperfect. Now, add a huge amount of volatility. NFT markets move fast and loose in both directions.

** **Due to this high volatility, NFT lending has been, so far, limited to bluechip projects such as Punks or Apes. Moreover, lenders often only offer low loan-to-value (LTV) ratios to help protect themselves with a margin of safety.

** **Both valuation and volatility will become more manageable as data becomes more abundant and the market matures, but it still leaves an elephant in the room... A lack of diversification and scalability.

Diversification

NFT lending occurs against single NFTs. Given the inherent issues with valuing NFTs and their volatility, lending against single NFTs is risky. Pooling NFTs and then lending against a diversified basket could significantly de-risk and help standardise the process. Think CDOs (collateralized debt obligations) for NFTs… Whale has made a start in this respect by bundling NFTs together and tokenising access to the portfolio.

NFTs will continue to evolve as an asset class. More real-world assets, that have an established track record and valuation methodology, will move on-chain. I’m excited to see this space take off, not only for private individuals, but also for businesses too - use cases feel almost infinite.

Projects worth a closer look

(I’m not endorsing, please do your research)

If you haven't already taken a look at some projects in the space to get a feel for where we are headed.

NFTfi is perhaps the most well known player in the NFT lending space, but a handful of others are also trying to gain market share:

• NFTfi

• Drops

• NiftyPays

• Euler

• Strip

• Nexo

• Arcade

Conclusion

The NFT market will 100x from here, as decentralised finance (DeFI) unlocks the next wave of innovation. Everyone is talking about 2022 being the year of the DAO, but I’m just as excited about the collision of DeFi and NFTs. NFTs are not all about PFP JPEGs, they are a foundational element of the metaverse. NFT lending will continue to evolve beyond Bluechip projects as pooling of collateral and data improve.